Is Novartis AG’s (VTX:NOVN) P/E Ratio Really That Good?

Wade Goff

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Novartis AG’s (VTX:NOVN) P/E ratio to inform your assessment of the investment opportunity. Novartis has a P/E ratio of 16.46, based on the last twelve months. That corresponds to an earnings yield of approximately 6.1%.

See our latest analysis for Novartis

How Do I Calculate Novartis’s Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Novartis:

P/E of 16.46 = $89.52 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $5.44 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CHF1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Novartis grew EPS by a whopping 66% in the last year. And it has bolstered its earnings per share by 3.5% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does Novartis’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Novartis has a lower P/E than the average (21.1) P/E for companies in the pharmaceuticals industry.

SWX:NOVN PE PEG Gauge February 18th 19
SWX:NOVN PE PEG Gauge February 18th 19

Novartis’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

Remember: P/E Ratios Don’t Consider The Balance Sheet

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Novartis’s Balance Sheet

Novartis has net debt worth just 7.9% of its market capitalization. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Novartis’s P/E Ratio

Novartis has a P/E of 16.5. That’s below the average in the CH market, which is 17.9. The company hasn’t stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.

But note: Novartis may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.